Treasurys end lower after auction

Foreign demand weak, but domestic demand was strong

LeslieWines

NEW YORK (MarketWatch) -- Treasury prices closed fractionally lower Thursday, sending yields a touch higher, after an auction of $8 billion in new 10-year notes attracted only minor interest from foreign central banks.

Price action was restrained ahead of Friday's release of the employment report for February which will be carefully studied for clues as to the strength of the labor market and wage inflation, both of which figure prominently in Federal Reserve interest rate decisions.

The benchmark 10-year Treasury note closed down 1/32 at 98-6/32 with a yield
$TNX
of 4.730%.

The 10-year note auction produced a very low 5.5% of indirect bids, the carefully watched category that includes foreign central banks and other institutions.

The fixed-income market is nervous that foreign central banks will ease away from funding U.S. debt.

The average indirect bid for the last 10 auctions was 28%, although historically foreign bank have not been big buyers at reissuances, according to Kevin Giddis, managing director of fixed income at Morgan Keegan.

The latest sale actually was a reopening of a prior 10-year note sale and covered 9-year and 11-month notes.

The auction also produced a high yield of 4.760%, the highest yield since June, 2004, and a low yield of 4.747%.

The bid to cover - or bids rendered to bids accepted - ratio was 2.87, a level that is considered "firm," according to Action Economics. The strong ratio indicates strong domestic demand.

Overall, the Treasury market has sold off heavily this week, a development that pushed yields up to levels attractive enough to lure some once-reluctant investors to the fixed-income market.

This week's selling has been sparked by indications that the Federal Reserve and foreign central banks will be forced to keep lifting rates to slow inflation this year.

Overnight the Bank of Japan put in place subtle changes to its monetary policy. The central bank will leave in place its zero interest policy, but will change its liquidity targets.

The bank's focus in coming weeks will be eliminating excess cash as its seeks to lower the current account balance from its current range of 30 trillion to 35 trillion yen down to 6 trillion yen. See full story.

In addition, the European Central Bank recently has signaled that it also may become more aggressive on rates this year.

Tony Crescenzi, chief bond market strategist at Miller Tabak, noted concern in the bond market that the Bank of Japan's tightened monetary policy could influence the central bank to reduce its Treasury holdings.

Japan, which owns $685 billion in Treasurys but has not purchased any in 18 months, is second only to the Fed, which has $736 billion in Treasurys and is the largest holder, he said.

Crescenzi said these fears are overblown. "With Japan likely to continue to earn dollar reserves and with its period of diversification already progressed, Japan is not likely to be a major seller of Treasurys for some time," he said.

The worries about whether foreign central banks are backing away from U.S. assets were reinforced after the Commerce Department reported that the nation's trade gap widened 5.3% to a new monthly record of $68.5 billion. The previous record was $67.84 billion in October. Read full government report.

Economists surveyed by MarketWatch had expected the deficit to increase to $66.4 billion. See Economic Calendar.

Analysts said the rising deficit is linked to higher oil prices and relatively weak foreign economic growth and expressed concerns about how the trade gap is impacting the structure of the domestic economy.

"The trade deficit exceeds 6% of gross domestic product and is weighing down economic growth," said Peter Morici, a business professor at the University of Maryland.

"Longer-term, persistent U.S. trade deficits are a substantial drag on growth," Morici said.

Alan Tonelson, a research fellow at the U.S. Business and Industry Council, said, "The January trends spotlight the continued decline of national competitiveness in industries of the future, such as high-tech hardware and services, and throughout our vital manufacturing sector."

The Labor Department said initial jobless claims rose by 8,000 to 303,000 in the latest week.

Economists expected a slight drop in initial claims to about 293,000, according to the MarketWatch survey. See Economic Calendar.

Investors cheered the end of the yield inversion in the Treasury market. On Wednesday and Thursday the yield on the 2-year note ended below the 10-year yield.

The inversion in prior sessions had spooked some analysts, as it can be an indication of a looming inflation.

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